The ultimate guide to saving for a new home

Buying a home is one of the most significant financial decisions you will make in your lifetime. For many Americans, saving for a purchase of that magnitude can feel impossible. The good news is there is no shortage of strategies you can choose from. The number one factor to consider (apart from your income) is how much time you have to save. Depending on when you plan on buying, some options may be better than others.

Here’s a guide to saving for a new home with various timelines in mind.

If you want to buy a home in the next 3 years...

Every investment option comes with a degree of risk, and with only a few short years to save, it’s likely not a wise idea to take big risks with your savings. The last thing you want is for the money to lose value without enough time to recover.

In this case, you should be looking for savings options that offer safety rather than growth, like a high-yield savings account and certificates of deposit (CDs). These are very low risk and, best of all, come with guaranteed returns on investment. If you’re looking for the highest paying savings accounts in your area, you can use our free comparison tool. We also have a list of the best CDs for the month.

If you want to buy a new home in 4 to 7 years...

The longer you have to save for a home, the more creative you can be with your investing strategy. The key is to strike the right mix between safety and growth. You want your money to grow at a comfortable enough pace to beat inflation but maintain enough conservative investments to offset any potential losses you might experience in the market.

You may be able to achieve this with a 25/75 portfolio.

The 25/75 portfolio strategy is pretty simple — no more than 25% of your money is invested in stocks, and the remaining 75% are in bonds. This blend of stocks and bonds should allow your money to grow modestly while keeping safety top of mind. You can start this process by opening a brokerage account and choosing your own mutual funds to reach the right mix. But do your research first. For example, U.S. News & World Report maintains a list of funds that are ranked for their allocation, fees, and performance.

If you want to buy a home in 8 to 10 years…

Time is certainly on your side if you’ve got nearly a decade to save for your dream home. The key is taking on the right amount of risk. Because you have so much time to save, you can afford to take riskier investment bets, which can potentially reap much higher rewards in the long run.

Consider a 50/50 investment strategy: You’ll invest 50% of your savings in stocks and 50% in bonds. You should have just enough risk to ensure you’ll beat inflation and then some, but still be conservative enough to be able to weather any downturns in the market. To achieve the perfect 50/50 mix, you could split your money evenly between your own selection of stocks and bonds. For those who like a more hands-off approach, U.S. News & World Report has a ranking of mutual funds that are preset to give you the 50/50 allocation. There you can select the fund you feel suits you best.

Deciding where to invest

Where you invest your money matters. Save your money in the wrong place and taxes could eat up a portion of your gains each year. You could also be in a situation where taking the money out to buy a home could cause a penalty as well.

If you plan on buying a home in five years or more, strategically using a Roth IRA could be your best option. With a Roth IRA you can withdraw all of your contributions without penalty; additionally, you can withdraw $10,000 of the earnings without tax or penalty for a first-time home purchase.

Lastly, a plain brokerage account may suit you. There are no tax advantages to investing here, but if you’re using the account to buy a home in the future, there may be more benefits in other areas. You can only contribute $5,500 ($6,500 after age 50) in a Traditional IRA or Roth IRA, and withdrawals are subject to strict rules. A regular brokerage account, on the other hand, has no limits to what you can put in or take out for home purchases or any other purchases. Take a look at your situation and see which options fit you best.

What about my 401(k)?

A common question most people ask is whether they should use their 401(k) to grow the money and then use it to buy a home. This is usually a bad idea. If you withdraw the money before age 59½, you would be subject to a 10% penalty, plus income taxes on top of that amount. In addition, the amount that you withdraw could severely alter your retirement goals. This is called an opportunity cost.

A better idea, though still not one we recommend, is taking a loan from your 401(k). You are allowed to take a loan of up to $50,000 or half the value of the account balance, whichever amount is less. This is still a loan, however, meaning it could affect your ability to qualify for a mortgage. You also have to pay this loan back. Depending on your company’s 401(k) rules, if you leave the company, the entire balance of the loan might come due within 60 to 90 days after you leave. If you stay with the company, you could be required to pay the loan back within five years.

Thankfully, your 401(k) isn’t your only option. Taking money from a Traditional IRA is a bit better. You are allowed to withdraw $10,000 without penalty for a first-time home purchase. This may change your tax situation as any withdrawal would have to be counted as part of your regular income. For most people this still isn’t the best option but certainly better than dipping into your 401(k).

MagnifyMoney is a price comparison and financial education website, founded by former bankers who use their knowledge of how the system works to help you save money.